All of those vehicle installment contracts with terms of 72 months or longer are prompting one of the top federal regulators of commercial banks to keep a close eye on auto financing.
The latest report from the Office of the Comptroller of the Currency indicated that agency officials continue “to closely monitor underwriting practices and loan structures.” They made the statement as part of the 41-page semiannual risk perspective by the OCC’s national risk committee.
The OCC based its assessment on data through the end of last year, which showed total outstanding balances in the industry’s portfolio reached $956 billion, increasing 1.4 percent for the quarter and 8.8 percent for the year. The OCC acknowledged outstanding balances have grown for 17 straight quarters, a trend that began in the third quarter of 2010.
Officials pointed out auto origination volumes at commercial banks followed a similar pattern with a 9.5-percent increase during 2014 and a “long-term pattern mirroring the industry.” To date, they added delinquency and loss rates remain within “manageable” levels, aided by declining unemployment, low gasoline prices and “resilient” used-vehicle prices.
While installment contract performance currently remains “reasonable,” the OCC discussed what negatives might be percolating within the industry.
“Extended rapid growth is difficult to maintain and can sometimes mask early signs of weakening credit quality,” officials said in the report. “Too much emphasis on monthly payment management and volatile collateral values can increase risk, and this often occurs gradually until the loan structures become imprudent.
“Signs of movement in this direction are evident, as lenders offer loans with larger balances, higher advance rates and longer repayment terms,” they continued. “Each on its own may be manageable depending on the particular case, but combining the factors substantially increases risk.”
As dealer finance office managers and finance company underwriters often see, those contract terms regularly need to be stretched to place the buyer into an affordable monthly payment. The OCC reiterated this practice can increase risk to banks and borrowers.
The agency mentioned 60 percent of auto loans originated in the fourth quarter of 2014 had a term of 72 months or longer.
“Extended terms are becoming the norm rather than the exception and need to be carefully managed,” officials said.
The OCC noted in its reported collateral advance rates are a concern, too.
The agency referenced Experian Automotive data on origination loan-to-value (LTV) ratios, which showed average advance rates were “well above” the value of the vehicles financed.
In the fourth quarter of 2014, the average LTV for used vehicle contracts was 137 percent. Moreover, advance rates for borrowers across the credit spectrum are trending up, with used vehicle LTVs for subprime borrowers (individuals with credit scores 620) averaging nearly 150 percent at the end of 2014.
“Sales of add-on products such as maintenance agreements, extended warranties, and gap insurance are often financed at origination. These add-on products in combination with debt rolled over from existing auto loans contribute to the aggressive advance rates,” the OCC said.
The regulator closed its report segment focused on the auto space by projecting how commercial banks might act going forward.
“As in the mortgage markets, the OCC expects banks to fully consider cycles and trends in the auto markets and respond in a prudent and sound manner,” officials said.
“Underwriting standards and product structures established in times of low interest rates and unusually high used car values may not prove prudent when conditions normalize or during times of stress,” they continued. “Competitive factors are important realities, but lenders also need to consider the results objectively and ensure that loan terms, underwriting standards, and portfolio concentrations remain within established and prudent risk appetite levels.”